Most people are probably familiar with net worth–the term is often used in the personal finance world. What about liquid net worth though? The purpose of this post is to go in depth on liquid net worth–what it is, how to calculate it, why it matters, how to increase it, and much more.
What is Net Worth?
Before we address liquid net worth, it’s important to write about net worth. The formula to calculate net worth is assets minus liabilities. The answer to that math problem is your net worth.
Assets are things like real estate holdings, cash, stocks, bonds, etc. Examples of liabilities include what you owe on your house, rental properties, cars, student loans, etc.
Here’s an example of how to calculate net worth using numbers (fictional numbers):
| Assets | Liabilities |
| House: $650,000 | Mortgage Balance: $350,000 |
| Rental Property: $200,000 | Mortgage Balance (Rental Property): $80,000 |
| Stocks: $135,000 | Car Loan Balance: $5,700 |
| Bonds: $25,000 | Student Loans: $8,900
|
| Savings Account: $11,000 | Credit Card Balance: $1,500 |
| Emergency Fund: $28,000 | N/A |
| Total: $1,049,000 | Total: $446,100 |
$1,049,000 (Assets) – $446,100 (Liabilities) =$602,900
After subtracting liabilities from assets, the person in this example has a net worth of $602,900.
Liquid Net Worth
To calculate liquid net worth, you’ll want to subtract liabilities from liquid assets. Liquid assets are assets that can be accessed relatively quickly. Examples include stocks, bonds, cash, savings accounts, etc. An asset like a house or rental property is not considered a liquid asset because it can take a while to get the money from them.
The formula to calculate liquid net worth is similar to how we calculated net worth, but with a major difference. In the liquid net worth formula, we cannot include assets that are not liquid. So things like houses, rental properties, and other non-liquid assets would not be included.
As an example, I’ll use the same table as I showed above but will strike through the assets that aren’t liquid.
| Assets | Liabilities |
| House: $650,000 | Mortgage Balance: $350,000 |
| Rental Property: $200,000 | Mortgage Balance (Rental Property): $80,000 |
| Stocks: $135,000 | Car Loan Balance: $5,700 |
| Bonds: $25,000 | Student Loans: $8,900
|
| Savings Account: $11,000 | Credit Card Balance: $1,500 |
| Emergency Fund: $28,000 | N/A |
| Total: $199,000 | Total: $446,100 |
$199,000 (Liquid Assets) – $446,100 (Liabilities) =$-247,100
The person in this example has a negative liquid net worth of $247,100.
What’s the Difference Between Net Worth and Liquid Net Worth?
Net worth includes all of your assets minus liabilities. Liquid net worth includes only liquid assets minus liabilities. For many people, especially those with large real estate holdings, they find that their liquid net worth is often far less than their net worth. To review:
- Net worth= Assets minus liabilities
- Liquid net worth= Liquid assets minus liabilities
Is Liquid Net Worth Important?
There’s some gray area to this question. Liquid net worth is important in the sense that it often indicates your ability to have enough money to pay for emergencies and to fund time-sensitive investments.
For example, if you have an unexpected bill that comes your way, it’s important to have money to pay for that emergency. Or if there’s a time sensitive investment opportunity that comes your way, it’s nice to have the cash to fund that investment. Someone with a high liquid net worth will be able to cover both of these items.
Looking from another vantage point, there’s also a point where liquid net worth has diminishing returns, most notably in the case of cash reserves. For example, someone who has a high paying job who saves 30 percent or more of her income and has an emergency fund of six to 12 months is doing really well. She has the high paying job plus several months of runway should anything go wrong.
If this same person continues to build up an emergency fund of say, three to four years–that money is not as useful as before. She already has the high paying job and a large emergency fund. How much is enough to have in an emergency fund? There’s a point where the money would be better served somewhere else.
Of course personal finance is personal so if having an extra-large emergency account helps someone sleep better at night, there’s nothing wrong with that. It may not be optimal, but it’s not necessarily wrong. There are a lot of ways to win with money, and everyone has a path they are comfortable with.
Related:
Why the Pandemic Prompted Me to Increase My Emergency Fund
The Broken Down Car and the Emergency Fund
Different Definitions of Liquid Net Worth
There’s not a uniform definition of liquid net worth. Some consider it to be money you can access quickly, like within a period of 48 hours or less. Other people may consider it money you can access within a week or two.
Depending on your definition, you might be able to expand it to include things like cars and houses.
Cars and Houses
Here’s what I mean: If you have a car worth $45,000 there’s a good chance you could lower the price to $20,000 and have the car sold in a couple hours.
That wouldn’t be smart because you’re potentially losing $25,00 off the real value of the car. But the point is that the car can be liquidated very quickly. So if someone added $20,000 to their liquid net worth because of devaluing the car, that would make sense.
Same thing with a house. If someone owned a house worth $900,000 they could probably drop the price to $600,000 and find a cash buyer to close in a few days. Just like with the car example–not an optimal investment strategy.
But again it’s an example of turning a traditionally non-liquid asset into a liquid asset. Obviously it would be the smarter move to find a buyer who is willing to pay closer to the real value of the home, but this is an example of what I mean by different definitions.
Stocks and Bonds
I’ll give another example. Stocks and bonds have traditionally been considered liquid assets. You can sell them quickly and get the cash if needed. However, what if the market dropped 30 percent over the last six months?
Sure, the stocks or bonds could be liquidated, but is it a smart move? I don’t think so because you’re not allowing time in the market to correct any downturns. I would argue that it’s just as much of a bad move to pull out stocks that have lost 30 percent of their value as it is to sell a car or house for half of its value.
In a scenario like this, is that asset really liquid?
How to Increase Liquid Net Worth
There are many ways to increase liquid net worth, I’ll outline a few below.
Eliminate Unnecessary Expenses
This is a good place to start because it lays the foundation for good financial habits. Go through all your spending for the past few months and decide:
- What is a necessity
- What you value (rate 1-10)
You can track the items by hand, using a spreadsheet, an app like Mint, or download the spending tracker I created. Anything that is not a necessity or rated low on the value scale are candidates to be eliminated. Examples include an online subscription you don’t use anymore, certain clothes, household items, trips, etc.
Identify the non-essentials that you don’t value, and consider eliminating them. Going through this exercise involves value-based spending, a core principle of how I turned around my own personal finance situation. Many people I’ve talked to are able to eliminate hundreds of dollars in monthly expenses just by going through this process.
The money saved by eliminating the unnecessary and unvalued naturally increases liquid net worth because it’s money you are not spending. Over longer periods of time, this money begins to compound, further increasing the amount.
Create an Emergency Fund
Most financial experts recommend an emergency fund be kept in a liquid account like savings so that it can be accessed quickly if needed. The amount of money kept in an emergency fund varies and depends on a number of factors addressed in this post I wrote on the topic.
Any money saved in your emergency fund will increase your liquid net worth just by the very nature of the emergency fund being liquid. For example, someone who has $24,000 in their emergency fund can add that amount to their liquid net worth. Similarly, someone with $19,000 in their emergency fund would add that as well.
Pay Off Consumer Debt
Consumer debt counts against liquid net worth. So reducing and eliminating consumer debt naturally increases it. As one (consumer debt) decreases, the other (liquid net worth) increases. Here are a couple examples:
- An investor with a $100,000 liquid net worth and $10,000 of consumer debt would increase their liquid net worth to $110,000 by paying off the debt.
- An individual with $400,000 liquid net worth and $25,000 of consumer debt: Paying off the $25,000 of consumer debt would increase their liquid net worth to $425,000.
Invest Higher Percentage of Income
The more amount of money you invest, the more your net worth will grow. And the more you invest in a liquid asset, the more your liquid net worth will grow. This is assuming your investments are making money, which historical averages suggest they will.
- An individual contributing $6,000 per year to an index fund averaging a 10 percent rate of return will increase their liquid net worth by $108,601 after 10 years.
- An investor contributing $10,000 per year to a portfolio of stocks and bonds averaging 8 percent a year will increase their liquid net worth by $159,616 after 10 years.
What I Focus On
I personally am more focused on building my net worth. I think liquid net worth is an important metric to a degree, but not as important to me as net worth. The way I view it is I want to have some money to cover emergencies and for investment opportunities.
Other than that, I don’t need a high liquid net worth. I have a propensity for non-liquid assets and will continue that investment pattern. Here’s an example using two fictional people to illustrate my point:
- Person 1: $4.5 million net worth, $75,000 liquid net worth
- Person 2: $450,000 net worth, $80,000 liquid net worth
Even though the second person has a higher liquid net worth I’d much rather be the person in the first example with the higher net worth. As long as there are sufficient cash reserves, I feel good about maintaining assets that aren’t as liquid.
Conclusion
Liquid net worth is a fun topic to think and write about, but you may decide it’s really not that important to you. If you’re a high net worth individual who keeps a large emergency fund, liquid net worth may not matter to you as much either. However, if you’re someone who wants to keep the majority of your assets liquid, it is an important topic.
There’s really not a right or wrong answer as long as you’re following sound financial principles. We all have our own values and needs. Financial success is rarely a one size fits all formula.
